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13) How did the international monetary system created at Bretton Woods in 1944 allow its members to
reconcile their external commitments with their internal goals of full employment and price stability?
14) Discuss the impact of the restoration of convertibility in 1958.
15) Explain how a country with a current account deficit is a ripe candidate for currency devaluation.
16) Explain how a country with a current account surplus is a ripe candidate for currency revaluation.
19.6 Analyzing Policy Options for Reaching Internal and External Balance
1) When the exchange rate, E, and the foreign price level, P*, is fixed, domestic inflation depends
primarily on:
A) amount of aggregate demand.
B) home price level set by IMF.
C) current account balance.
D) government tax policy.
E) foreign interest rates.
2) The current account surplus is
A) an increasing function of disposable income and an increasing function of the real exchange rate.
B) a decreasing function of disposable income and a decreasing function of the real exchange rate.
C) a decreasing function of disposable income and an increasing function of the real exchange rate.
D) only a decreasing function of disposable income.
E) only an increasing function of the real exchange rate.
3) Under fixed exchange rates,
A) Monetary policy is not an effective policy.
B) Fiscal policy is not an effective policy.
C) Monetary policy and fiscal policy are not effective.
D) Both monetary and fiscal policies are effective.
E) Monetary policy has an unpredictable effect on the domestic money supply.
4) Under fixed exchange rates, domestic asset transactions by the central bank
A) can be used to alter the level of foreign reserves but not to affect the state of employment and output.
B) cannot be used to alter the level of foreign reserves but only to affect the state of employment and
output.
C) can be used to alter the level of foreign reserves and to affect the state of employment and output.
D) can be used to alter the domestic money supply and the level of foreign reserves
E) can raise output to full-employment level
5) The XX schedule shows how much
A) fiscal expansion is needed to hold the current account surplus at X as the currency is devalued by a
given amount.
B) monetary expansion is needed to hold the current account surplus at X as the currency is devalued by
a given amount.
C) fiscal expansion is needed to hold the current account surplus at X as the currency is evaluated by a
given amount.
D) fiscal and monetary expansions are needed to hold the current account surplus at X as the currency is
devalued by a given amount.
E) foreign funding is needed to hold the current account surplus at X as the currency is devalued by a
given amount.
6) The current account surplus
A) is a decreasing function of disposable income and an increasing function of the real exchange rate.
B) is an increasing function of disposable income and an increasing function of the real exchange rate.
C) is an increasing function of disposable income and a decreasing function of the real exchange rate.
D) is a decreasing function of disposable income and a decreasing function of the real exchange rate.
E) is an increasing function of disposable income and a decreasing function of aggregate demand
7) Fiscal expansion
A) stimulates aggregate demand and causes output to decline.
B) decreases aggregate demand and causes output to decline.
C) stimulates aggregate demand and causes output to rise.
D) decreases aggregate demand and causes output to rise.
E) decreases government expenditures.
8) A devaluation of the home currency
A) makes foreign goods and services cheaper relative to those sold at home.
B) makes domestic goods and services more expensive relative to those sold abroad.
C) decreases demand and output.
D) increases demand for domestic goods and services.
E) increases output and makes domestic goods and services cheaper relative to those sold abroad.
9) An attempt by a central bank to alter the money supply by buying or selling domestic assets
A) will leave both domestic money supply and foreign reserves unchanged.
B) will cause an offsetting change in aggregate demand.
C) will lead to a rise in domestic employment and output.
D) will lead to a decrease in domestic employment and output.
E) will cause an offsetting change in foreign reserves and leave the domestic money supply unchanged.
10) An expenditure-changing policy
A) alters the direction of the economy's total demand for goods and services.
B) alters the level of the economy's total demand for goods and services.
C) has no effect on aggregate demand.
D) is the same thing as an expenditure-switching policy.
E) affects aggregate supply but not aggregate demand.
11) The alteration of exchange rates to move the economy to internal and external balance may lead to
all except
A) a balance of payments crisis.
B) changes in the terms of trade.
C) changes in the level of imports or exports.
D) changes in interest rates.
E) a guaranteed unilateral improvement in economic wealth.
12) "A monetary policy is not a policy tool under fixed exchange rates." Discuss.
13) What is the difference between an expenditure-changing policy and an expenditure-switching
policy?
14) (a) Assume that R denotes the domestic interest rate and R denotes the foreign interest rate. Under
a fixed exchange rate what is the relation between R and R
(b) Assume E denotes the domestic currency price of the dollar for a country which is not the United
States. If one wants to analyze only the short run effects of a policy, what does one assume about the
Home and Foreign price levels, P and P , respectively.
(c) Assume that there is no ongoing balance of payment crisis. What is this assumption really assume?
(d) Assume a fixed exchange rate system. What does this tell you about E?
(e) Under the above assumptions what are the conditions for internal balance?
(f) How is your answer to Part D above would change if P is unstable due to foreign inflation.
(g) Given the definitions above, how one defines the real exchange rate?
(h) Write the condition for internal balance.
(i) Define the variable not defined before in Part G above.
(j) Using the equation for internal balance derived above, given our assumptions analyze the effects of a
fiscal expansion.
(k) What would happen if the government of that country, which is not the United States under Bretton
Woods, decides to devaluate its currency?
(l) What would happen if the government of that country, which is not the United States under Bretton
Woods, decides to use monetary policy rather than fiscal policy?
(m) Given all of the above, what is the relation between the exchange rate, E, and fiscal ease, i.e., an
increase in G or a reduction in T?
(n) Assume that the economy is at internal balance. What will happen if G goes up for a given level of
E?
(o) Assume that the economy is at internal balance. What will happen if G goes down for a given level
of E?
15) Assume that the government has a target value, X, for the current account surplus.
(a) What is the goal of external balance?
(b) Assume that we are dealing with only the short run, what are the values of P and P∗?
(c) Given fixed P and P , what would happen if E rises?
(d) Given P and P , what would happen if T decreases, i.e., an expansionary fiscal policy?
(e) Given P and P , what would happen if G increases, i.e., an expansionary fiscal policy?
(f) Given all of the above, what is the relation between the exchange rate, E, and fiscal ease, i.e., an
increase in G or a reduction in T?
(g) Assume that the economy is in external balance. What will happen if the government maintains its
current account at X, but devaluates the domestic currency?
(h) Assume that the economy is at external balance. What will happen if the government raises E?
(i) Assume that the economy is at external balance. What will happen if the government lowers E?
16) Use a figure below to describe the four zones of economic discomfort.
17) Using the II-XX framework, show using a figure that fiscal policies by themselves cannot bring the
economy to both internal and external balances.
19.7 The External Balance Problem of the United States Under Bretton Woods
1) The confidence problem of the Bretton Woods systems articulated by Robert Triffin refers to
A) the unwillingness of central banks to accumulate currency for fear of not being able to convert it to
gold in case a run on the banks occurs
B) consumer fear of stock market instability
C) producer fear of rising wages
D) the lack of convertibility of gold into silver
E) low consumer spending because of balance of payment crises.
2) A two-tier gold market like the one created during the Bretton Woods System refers to
A) a private tier for private gold traders where the price would not be allowed to fluctuate, and an
official tier for central banks where the official gold price would be allowed to fluctuate.
B) a private tier for private gold traders where the price would not be allowed to fluctuate, and an
official tier for central banks where the official gold price would rise on a yearly basis by pre-
determined increments.
C) a private tier for private gold traders where the price would be allowed to fluctuate, and an official
tier for central banks where the official gold price would be set at $35 an ounce.
D) a private tier for private gold traders where the price would be set at $35 an ounce, and an official tier
for central banks where the official gold price would be allowed to fluctuate.
E) a private tier for private gold traders where the price of gold would rise on a yearly basis by pre-
determined increments, and an official tier for central banks where the official gold price would be set at
$35 an ounce.
3) In order to bring about a real depreciation of the dollar, the U.S. can hope for
A) a rise in the U.S. price level.
B) a fall in foreign price levels.
C) a rise in the dollar's nominal value in terms of foreign currencies.
D) a rise in foreign price levels or a fall in the dollar's nominal value in terms of foreign currencies.
E) increased output and full employment.
4) The collapse of the Bretton Woods system marked
A) the end of floating exchange rates and a move to fixed exchange rates.
B) marked the end of fixed exchange rates and a move to floating exchange rates.
C) the beginning of the gold standard.
D) a plunge in the price of gold.
E) the elimination of paper currencies.
5) Which of the following statements is most accurate?
A) A revaluation restores internal and external balance immediately, without causing domestic inflation.
B) A devaluation restores internal and external balance immediately, without causing domestic inflation.
C) A revaluation restores internal and external balance immediately, but also causes domestic inflation.
D) A devaluation restores internal and external balance immediately, but also causes domestic inflation.
E) A devaluation restores external balance in the long run, without causing immediate domestic
inflation.
6) Which of the following is the most accurate?
A) U.S. macroeconomic policies in the late 1960s helped cause the breakdown of the Bretton Woods
system by early 1973.
B) U.S. macroeconomic policies in the late 1970s helped cause the breakdown of the Bretton Woods
system by early 1983.
C) U.S. macroeconomic policies in the late 1980s helped cause the breakdown of the Bretton Woods
system by early 1993.
D) U.S. macroeconomic policies in the late 1950s helped cause the breakdown of the Bretton Woods
system by early 1963.
E) U.S. macroeconomic policies in the late 1960s delayed the breakdown of the Bretton Woods system
to early 1973.
19.8 The Mechanics of Imported Inflation
1) Refer to the graph below, which shows the effect of ________ on the home economy.
A) foreign inflation
B) domestic inflation
C) foreign deflation
D) domestic recession
E) foreign recession
2) Refer to the graph below. The movement from point 1 to point 2 is stimulated by a disequilibrium in
which there is domestic ________ and ________.
A) overemployment; trade surplus
B) unemployment; trade surplus
C) overemployment; trade deficit
D) unemployment; trade deficit
E) inflation; unemployment
19.9 The Case for Floating Exchange Rates
1) Advocates of floating rate suggested it is favorable for economies for the following reasons except
A) it discourages attack from foreign exchange speculators because of the fact that exchange rate
adjustment is immediate.
B) it helps stabilize the shock effect on unemployment in case of economic changes such as fall in
export demand.
C) it automatically matches the domestic inflation with ongoing foreign inflation.
D) it gives every country the opportunity to guide its own monetary conditions at home.
E) it brings the LR exchange rate to the level predicted by PPP without government policy decisions.
2) Which of the following is not a result of a temporary fall in foreign demand on one country's exports
under floating exchange rate?
A) The DD curve shifts to the left due to reduction of aggregate demand.
B) The AA curve shifts downwards due to reduction of money supply.
C) a fall in aggregate output
D) depreciation in home country's currency
E) a fall in the home interest rate
3) Which of the following is not a result of a permanent fall in foreign demand on one country's exports
under floating exchange rate?
A) The DD curve shifts to the left due to reduction of aggregate demand.
B) The AA curve shifts upwards due to the increased expected long-run exchange rate.
C) a reduction in output by a smaller degree compared to temporary fall in demand
D) depreciation in home country's currency
E) a raised level of unemployment
4) Which of the following is/are INCORRECT?
An argument against floating exchange rates is that
A) a fixed rate automatically prevents instability in the domestic money market from affecting the
economy if shocks come from home domestic money market.
B) a fixed rate might become unpredictable, complicating economic planning.
C) a rise in money demand under a fixed exchange rate would have no effect on the exchange rate and
output.
D) a fixed rate functions within the price-specie-flow mechanism and maintains a balance of payments
equilibrium,
E) a fixed rate automatically prevents instability in the economy from output market shocks.
5) If central banks were no longer obliged to intervene in currency markets to fix exchange rates,
governments would be able to use monetary policy to reach
A) internal balance.
B) external balance.
C) internal and external balance.
D) internal but not external balance.
E) external but not internal balance.
6) Advocates of flexible exchange rates claim that under flexible exchange rates,
A) no country would be forced to import only inflation from abroad.
B) no country would be forced to import only deflation from abroad.
C) no country would be forced to import inflation and deflation from abroad.
D) flexible exchange rates are not able to halt importing inflation from abroad.
E) flexible exchange rates are not able to halt importing deflation from abroad.
7) Advocates of flexible exchange rates claim that under flexible exchange rates,
A) the United States would now be able to set world monetary conditions all by itself.
B) Germany would no longer be able to set world monetary conditions all by itself.
C) the United Kingdom would no longer be able to set world monetary conditions all by itself.
D) the United States would no longer be able to set world monetary conditions all by itself.
E) Germany would now be able set world monetary conditions all by itself.
8) Advocates of flexible exchange rates claim that under flexible exchange rates,
A) the United States would no longer have the same opportunity as other countries to influence its
exchange rate against foreign currencies.
B) the United States would have the same opportunity as other countries to influence its exchange rate
against foreign currencies.
C) the United Kingdom would not have the same opportunity as other countries to influence its
exchange rate against foreign currencies.
D) Germany would not have the same opportunity as other countries to influence its exchange rate
against foreign currencies.
E) China would have the same opportunity as other countries to influence its exchange rate against
foreign currencies.
9) Some claim that the long and agonizing periods of speculation preceding exchange rate realignments
would
A) not occur under fixed exchange rate regime.
B) not occur under floating.
C) become more severe under currency board.
D) become less severe under floating.
E) be prolonged under floating.
10) Advocates of floating rates pointed out that
A) removal of the obligation to peg currency values would restore monetary control to central banks.
B) imposing of the obligation to peg currency values would restore monetary control to central banks.
C) removing of the obligation to peg currency values would restore fiscal control.
D) imposing of the obligation to peg currency values would restore fiscal control.
E) imposing of the obligation to peg currency would restore monetary control to the consumer.
11) Advocates of flexible exchange rates claim that under flexible exchange rates, if the central bank
faced unemployment
A) and thus wished to decrease its money supply, there would no longer be any legal barrier to the
currency depreciation this would cause.
B) and thus wished to expand its money supply, there would no longer be any legal barrier to the
currency depreciation this would cause.
C) and wished to expand its money supply, there would no longer be any legal barrier to the currency
appreciation this would cause.
D) and wished to decrease its money supply, there now would be a legal barrier to the currency
depreciation this would cause.
E) and wished to increase output, there would no longer be a legal barrier to the currency appreciation
this would cause.
12) Advocates of flexible exchange rates claim that under flexible exchange rates, a currency
A) appreciation caused by increasing the money supply would reduce unemployment by lowering the
relative price of domestic products.
B) depreciation caused by increasing the money supply would increase unemployment by lowering the
relative price of domestic products.
C) depreciation caused by increasing the money supply would reduce unemployment by lowering the
relative price of domestic products.
D) depreciation caused by increasing the money supply would reduce unemployment by increasing the
relative price of domestic products.
E) depreciation cause by decreasing the money supply would not effect unemployment, but would
increase the relative price of domestic products.
13) Advocates of flexible exchange rates claim that under flexible exchange rates, a currency
A) depreciation caused by increasing the money supply would reduce unemployment by increasing
world demand for them.
B) appreciation caused by increasing the money supply would reduce unemployment by increasing
world demand for them.
C) appreciation caused by decreasing the money supply would reduce unemployment by increasing
world demand for them.
D) appreciation caused by increasing the money supply would increase unemployment by increasing
world demand for them.
E) appreciation caused by increasing the money supply would increase unemployment by decreasing
world demand for them.
14) Advocates of flexible exchange rates claim that under flexible exchange rates, a currency
A) depreciation caused by increasing the money supply would reduce unemployment by lowering the
relative price of domestic products and increasing the world demand for them.
B) appreciation caused by increasing the money supply would reduce unemployment by lowering the
relative price of domestic products and increasing world demand for them.
C) appreciation caused by decreasing the money supply would reduce unemployment by lowering the
relative price of domestic products and increasing world demand for them.
D) appreciation caused by increasing the money supply would increase unemployment by lowering the
relative price of domestic products and increasing world demand for them.
E) appreciation caused by increasing the money supply would increase unemployment by lowering the
relative price of domestic products and by decreasing world demand for them.
15) Advocates of flexible exchange rates claim that under flexible exchange rates, the central bank of
A) an overheated economy could cool down activity by increasing the money supply without worrying
that undesired reserve inflow would undermine its stabilization effort.
B) a cooled economy could cool down activity by contracting the money supply without worrying that
undesired reserve inflow would undermine its stabilization effort.
C) an overheated economy could cool down activity by contracting the money supply without worrying
that undesired reserve inflow would undermine its stabilization effort.
D) an overheated economy could cool down activity by contracting the money supply without worrying
that undesired reserve outflow would undermine its stabilization effort.
E) an overheated economy could cool down activity by decreasing employment and increasing output
without worrying that this would undermine its stabilization effort.
16) Advocates of flexible exchange rates claim that under flexible exchange rates,
A) enhanced control over fiscal policy would allow countries to dismantle their distorting barriers to
international payments.
B) reduced control over monetary policy would allow countries to dismantle their distorting barriers to
international payments.
C) enhanced control over monetary policy would allow countries to increase their distorting barriers to
international payments.
D) enhanced control over monetary policy would allow countries to dismantle their distorting barriers to
international payments.
E) enhanced control over monetary policy would destabilize exchange rates.
17) By the end of the 1960s, many countries felt that they were importing inflation from
A) the United States.
B) Germany.
C) France.
D) Japan.
E) the United Kingdom.
